Betting On A Red Horse

Ferrari 458 Speciale

Courtesy Ferrari N.A.

I’m not one to bet on horses. I never play the lotto (even with the record 10 figure jackpot currently in the headlines), and I have never even made it to a blackjack table in Vegas despite a few attempts. I didn’t even pay much attention to Williams Grand Prix, another stalwart of the Formula One (F1) circuit, when the company went public. But this time, it’s a little different. Ferrari is now a public company following a spin off from Fiat Chrysler (FCAU), and I have some shares of stock in the Prancing Horse.

The Legend

You might say I’m long on the legend of the Prancing Horse, which began with Enzo Ferrari (1898-1988) as a racing driver for Alfa Romeo in the early days of the automobile. Upon the birth of his son Alfredino (“Dino”), he retired from driving to concentrate on running Alfa’s F1 team, and then eventually setting up shop on his own.

In that bygone era of racing cars painted in national racing colors rather than adorned with sponsorship livery, road going Ferraris were sold to fund operations of the racing team. Ferrari has always been a company that sold cars to go racing, which is quite the opposite of most every manufacturer that has been involved with the sport before or since. It is also the one with the most wins and championships in F1, and the only one that has been part of the sport all through the post-WWII era, starting with the 1950 season.

Unsurprisingly in such a competitive business, the company’s fortunes ebbed and flowed over the years. Dino Ferrari, whom Enzo had likely been grooming to eventually takeover, tragically died of muscular dystrophy in 1956 at the age of 24. Then in the 1960s Ferrari almost sold the business to Ford but backed out. “The Deuce” (aka Henry Ford II) was incensed and commissioned the creation of the Ford GT40, which eventually ended Ferrari’s dominance of the famed 24 Hours of Le Mans endurance race, by winning four times straight beginning in 1966.

Fiat, under the leadership of Gianni Agnelli, bought a stake in the company in 1969 and later became the controlling shareholder. The company went on to some of its greatest successes after Enzo’s death in 1988, launching a slew of critically acclaimed and commercially successful models beginning in the 1990s and returning to its winning ways on the F1 circuit with a combined 14 driver and constructor titles between 1999 and 2008.

Green Pastures

Ferrari is a solid, if expensive investment. It is a trophy property after all. In the short term the share price is subject to fall due to the initial hype surrounding its IPO and the high Price/Earnings (P/E) ratio. However, over the long term I can’t think of many more solid investments in the “automotive” sector. Here’s why.

First, Ferrari currently produces about 7,700 cars per year. FCAU CEO Sergio Marchionne has already hinted that production will rise to about 9,000 cars per year. Worries that the brand will get diluted are unfounded. These are the same arguments purists made about Porsche and the Cayenne. And the German firm is doing better than ever. I hope Ferrari doesn’t make an SUV. But if they do expand production, be it with cars or other vehicles, the vehicles don’t necessarily have to be Ferrari-badged. Have you heard Maserati is coming out with an SUV? It could have a lot of Ferrari in it.

Even at 9,000 units per year, as long as demand exceeds supply and the company can maintain its margins, there should be no problem. With a years long waiting list for a new Ferrari and new, pricier models constantly in the pipeline, demand is likely strong enough to weather any foreseeable fluctuation without a big impact on the bottom line. Have you ever seen a new model Ferrari with a lower MSRP than the one it replaced? Neither have I. The clientele is also very loyal (not to mention wealthy), with 60 percent of new cars going to existing Ferrari owners.

While sales in China were down about 40 percent last year, largely due to a politically driven clampdown on conspicuous consumption, the USA, Europe, and Japan are the company’s biggest markets. Unless there is a huge global recession, I wouldn’t worry much. And if there were? I am betting the preeminent sports car manufacturer will be able to tighten its belt and make it through a downturn.

Further, licensing revenue is a highly profitable and growing portion of the company’s bottom line. You can be sure having its brand and logos adorning a wide variety of tchotchkes from keychains and hats to bicycles and theme parks doesn’t require much, if any, funds to be spent on research and development. Again, as long as management doesn’t water down the brand the golden goose should continue to lay plenty of golden eggs, some of which will offset the sums the company does spend on actual R&D for the cars.

Lastly, the major shareholders are the Agnelli family, Piero Ferrari who has a largely ceremonial role, and FCAU, currently headed by Sergio Marchionne. If anyone is going to muck things up, its likely one of those parties. But I don’t believe that is going to happen. Especially since Piero Ferrari and the Agnellis have agreed to a voting pact that essentially ensures they retain control of the company, with a combined total of close to 50 percent of the company.

By the way, the Ferrari ticker symbol is RACE. Which reminds me of some useless trivia. The stock ticker for Cummins, the truck and industrial engine manufacturer, is CMI. But years ago it was CUM. Make of that what you will.

Anyway, the stated reason for the spin off is that FCAU and Ferrari are worth more separately than combined. I bought FCAU at $11.21 per share in November 2014, and it’s traded above $14 on occasion. It’s currently trading at about $7.50 and Ferrari is currently at about $42 – quite a bit less than it’s $50-ish IPO price. FCAU shareholders, however, received one share of Ferrari for every 10 shares of FCAU, so effectively each share of FCAU after the spinoff is worth about $11.70 ($7.50 + $42.00/10).

Intriguingly, days after the spinoff FCAU was accused by some dealers of falsifying its sales numbers. Reminds me of vehicle recalls. Can you say scandal? Time will tell how this plays out. In the mean time the FCAU share price has taken a beating, the timing of the spinoff conveniently benefiting the aforementioned large shareholders, effectively shielding Ferrari’s stock price from FCAU’s market gyrations.

In short, my opinion is that Ferrari’s competitive position is solid. As long as demand is properly managed, the product pipeline continues to be developed as it has been for more than 20 years, and the main shareholders stay on even keel, this horse has the legs to run as it has for a long, long time. I’m in for a couple of grand (less than a Ferrari oil change?). The same can’t be said of FCAU. I might consider using options to straddle that mule.

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